APAC Realty - RHB Invest 2017-11-30: The Dawn Of A New ERA

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APAC REALTY LIMITED CLN.SI

APAC Realty - The Dawn Of A New ERA

• We initiate on APAC Realty – a holistic real estate services provider focused mainly in Singapore – with a BUY and a DCF-derived SGD1.20 TP (36% upside), implying 15x FY18F P/E. Its brokerage service, operating under the ERA brand, is a residential segment market leader in Singapore (37.5% market share in 2016). 
• We believe APAC Realty offers the best proxy for investors looking to tap into the surging residential volumes in Singapore, as earnings are predominantly volume-driven. We forecast a 14% increase in FY18F net profit after a 54% surge in 2017, on the back of the residential boom. 
• The stock also offers an attractive dividend yield of 4.4% (FY18) and its net cash position provides room for inorganic growth.

A holistic real estate services provider. 

• APAC Realty provides real estate brokerage services in Singapore under the ERA brand. The group also has exclusive regional master franchise rights in 17 countries in the Asia-Pacific region for ERA Realty Network Pte Ltd (ERA Realty). 
• Besides brokerage services, it also derives revenue from franchise, training, valuation and other ancillary services.

A proxy for the residential boom in Singapore. 

• YTD-October, Singapore’s primary home – excluding executive condominiums (ECs) – and secondary sales have increased by 45% and 67% respectively YoY. Meanwhile, the Property Price Index has only grown by 0.3%. 
• Unlike real estate developers, for which both volume and price recovery are needed for margins expansion, real estate agency commissions are driven purely by volume growth. Thus, we believe APAC Realty is a better way to play the strong buying momentum.

Market leader with strong pipeline of projects. 

• The group’s market share as a percentage of total transactions has been steadily increasing to 37.5% in 2016 from 25.7% in 2012. 
• A key contributor to this growth has been APAC Realty’s project marketing segment. The outlook for this segment seems bright, with ERA Realty already securing 10 projects for launch in 2018 of c.10,000 units. This is more than double the 4,800 units from eight projects in 9M17. 
• As of 3Q17, the group has the second-largest agent network, with a total of 6,285 agents, or c.21% of the total. Singapore accounted for the bulk (99.9%) of revenue in FY16.

Steady growth from the non-brokerage segment. 

• Non-brokerage gross profit accounted for 19% of FY16’s total and offers earnings stability as it is less cyclical vis-à-vis brokerage. Additionally, in our view, the wide range of training programmes APAC Realty offers, helps in retaining and attracting new agents. 
• We forecast a gross profit CAGR of 6% in 2016-2019 from this segment.

FINANCIALS

Forecasting a 3-year net profit CAGR of 21%. 

• We forecast for a healthy net profit growth of 54% and 14% for FY17-18 respectively. This comes on the back of a 3-year revenue CAGR of 13%, driven by a strong estimated rebound in property transaction volumes domestically. YTD 9M17, net profits rose by 65% to SGD 18.0m.
• In terms of revenue breakdown, brokerage income from new sales accounts for 23% of our FY17F total revenue, brokerage income from resale and rental property accounts for 76%, with the non-brokerage segment accounting for the rest.
• Gross margins are expected to improve slightly (+0.16ppts) for FY17, in our view, driven by higher primary sales volumes that command increased margins. The estimated better net margins of 6.5% and 6.8% for FY17-18 respectively (FY16: 5.5%) are derived from operating leverage from APAC Realty’s higher fixed cost structure.

Key assumptions. 

• The key drivers to our earnings model are: 
  1. Transaction volume growth;
  2. Market share; 
  3. Commissions as a percentage of transacted volumes.
• We have assumed for primary and secondary sales volumes in the private property market to rebound by 40% and 50% respectively for 2017. This is on the back of the strong pick-up in buying interest. Housing and Development Board (HDB) resale transactions are expected to grow 5% in 2017.
• Note that our assumptions are conservative, considering that the YTD-October private primary and secondary sales (private) segments have already increased by 45% and 67% respectively. For FY18 we assumed flat primary sales and a 12% increase in secondary (private) sales.
• On market share, in 2017 we are forecasting slight 2ppt and 0.5ppt declines for primary and resale market transactions respectively. This is due to increased competition and the ongoing consolidation in the domestic brokerage sector. The rental transaction market share is expected to remain fairly steady, in our view.

Sensitivity analysis. 

• As our earnings forecasts are highly sensitive to the underlying assumptions, we did a sensitivity study on APAC Realty’s transactions value growth and market share. Based on our calculations, every ±5% change in transaction value (primary and secondary combined) would result in a corresponding around ±6% change in FY18F net profit. Similarly, a ±1ppt change in market share would have an about ±4% impact on the group’s FY18F net profits.
• We believe our growth assumptions are conservative. We opine for potential earnings upside if the strong recovery in property transaction volumes continue and APAC Realty is able to grow its market share.

Earnings seasonality. 

• Based on historical data, the brokerage income for rental and resale transactions is typically stronger in the last two quarters of a year. The lower brokerage income in the first two quarters of any given year is mainly attributable to decreased transaction volumes in the year-end and Lunar New Year festive seasons. The time lag between the entry into and completion of such transactions is also a factor.
• For FY14-16, 1H rental and resale brokerage income typically accounted for 44-45%, with 2H accounting for the rest.

Steady growing recurring income base lends stability. 

• Gross Profit from APAC Realty’s non-brokerage business increased 4% YoY in FY16, and we forecast a 7% and 6% growth for 2017 and 2018 respectively. Such growth is expected to be driven by: 
  1. Increases in training demand;
  2. Higher demand for property valuations; 
  3. The property management segment.
• The growing non-recurring income – which is less cyclical to market conditions – is likely to provide earnings stability, in our view. 
• For FY16, non-brokerage Gross Profits accounted for 19.1% of total GPs. Training and property valuations are the biggest contributors to FY17F GPs, accounting for 20.1% and 19.7% respectively.
• Other operating revenue comprises, among others, incentive, referral and administration fee income, and professional indemnity insurance fees.

Operating leverage and costs. 

• We expect the opex as a percentage of revenue to come down to 5.8% by 2018 from 7.2% in 2016 – the key reason being economies of scale, as opex can be shared across a larger network of agents.
• About 68% of APAC Realty’s operating costs were fixed in nature for 9mFY17. While revenue grew by 32% in 2014-2016, opex only rose by 8% during the same period. For 9M17, opex (excluding the IPO expenses) as percentage of revenue stood at 6.2%.

Healthy dividend yield of 4.4%. 

• APAC Realty intends to pay out at least 50% of after tax net profit as dividends for FY17 (from the listing date) and FY18. In our model, we have assumed that the group would have a payout of 50% of FY18 earnings translating into a healthy dividend yield of 4.4%.

Strong net cash position and low capex requirements provides dividend upside. 

• As at 3Q17, APAC Realty has no debt and is in a SGD48.1m net cash position. With low capex requirements, the net cash position provides room for growth through acquisitions and higher dividends.

Taxation. 

• As the group’s operations are predominantly in Singapore, it is subjected to a corporate tax rate of 17%. For FY14-16, its effective tax rate stood at 18%, 17.9% and 16.9% respectively. The effective tax rates were generally higher than the statutory tax rates, mainly due to the effect of non-tax deductible expenses. 
• For forecasting in our model, we have assumed a standard tax rate of 17%.

VALUATION

• BUY with a TP of SGD 1.20. 
• Our DCF-derived TP is based on a: 
  1. Risk-free rate of 2.75%;
  2. Weighted average cost of capital (WACC) or Cost of Equity (COE) of 8%. In As the company is debt free, the WACC rate is equal to the COE; 
  3. 0% terminal growth.
• The TP corresponds to 15x FY18F P/E, which is at a 15% discount to the comparable global peers’ forward P/E average. This P/E multiple of 15x sounds fair, considering APAC Realty’s relatively smaller size and concentration on the domestic property market. 
• We have also provided a comparison of large-cap peers and one technology-based peer, which are currently trading at much higher P/E multiples.

FUTURE GROWTH STRATEGY

Expanding range of real estate services. 

• APAC Realty intends to grow its business by a two-fold diversification strategy. This is in order to achieve more stable earnings and stay ahead of the competition by: 
  1. Diversifying into other areas of real estate-related services that offer higher margins while maintaining a focus on the brokerage business;
  2. Increasing exposure to other sources of income, such as training, valuation, property management, commercial and industrial leasing, purchasing, auction, research and facilities management – all of which offer earnings stability.

Expanding its geographical presence in the Asia-Pacific region. 

• The group intends to expand and deepen its presence in key markets in the Asia-Pacific region, either by: 

1. Setting up brokerage offices;
2. Entering into sub-franchise arrangements with local operators; 
3. Acquiring an existing agent network (subject to any applicable non-compete restrictions).

• Key target markets in the near-term include China and Indonesia. Management believes such a strategy would help in developing an additional source of income, create synergies with its Singapore operations, and diversify its exposure to the domestic residential property market.

Enhanced technological capabilities. 

• APAC Realty plans to enhance its technological capabilities by creating and/or acquiring new tools to increase its business efficiency and offer better levels of service to its customers and agents. This would be achieved through investments and/or partnerships with third parties.
• The group currently offers various tools such as mobile applications (eg i-ERA and ERA SG Projects), a website (ERA Singapore), a customer relationship and management system (24/7 PropWatch) and MyERA, an internal portal used by its agents and customers to facilitate the execution of real estate transactions.

KEY RISKS

Loss of market share from industry consolidation. 

• Increasing compliance requirements, competition and poor market sentiment during the last few years have led to a consolidation among the smaller brokerages. If the consolidation trend intensifies and ERA Realty fails to maintain its market share or number of agents, it may have an adverse impact on APAC Realty’s topline and bottomline.

Technology advances squeezing commissions structures and margins. 

• The property market in Singapore, thus far, has been relatively less impacted by disruptors from the technology field. Further advancements in technology-enabled real estate products and governments’ digitalisation push could negatively impact its business model in the future.
• An entry into the market by overseas players such as Redfin (RDFN US, NR) and Purplebricks (PURP LN, NR) could also further squeeze the group’s commissions structure and margins.

Ability to retain key management and agents. 

• APAC Realty’s business model is heavily reliant on the performance of its management team and agents. Thus, the group’s ability to retain and continuously train its agents plays a crucial role in its success.

Reputation and brand damage. 

• The business is highly reliant on its brand image and goodwill among its customers. Any reputational damage to the ERA brand arising from potential misconducts of its employees (eg fraudulent conduct, adverse social media commentary, etc.) could have a negative impact to its operations.

Prolonged decline in the Singaporean economy. 

• APAC Realty’s performance is heavily correlated to the performance of the Singaporean economy and local property market. A prolonged decline in the economy, or decrease in real estate prices and transaction volumes, may hurt its financial performance.

Policy changes impacting the property sector. 

• The implementation of further cooling measures – in the form of additional taxes and lower loan to value (LTV) limits – could hurt demand for the residential sector. This would result in lower commissions.

Regulatory changes. 

• The brokerage sector in Singapore is regulated by the Council of Estate Agents (CEA). Any changes or tightening in regulations governing the industry players could potentially result in a loss of agents and lower commissions.

Relationships with property developers. 

• About 23% of APAC Realty’s revenue for FY16 was derived from the brokerage of new home sales. This segment’s revenue depends on ERA Realty’s close working relationships with property developers and the network’s execution abilities. Thus, deterioration in APAC Realty’s working relationships with major developers may negatively impact the performance of the segment.

Failure to renew license and franchisee rights. 

• An unexpected termination of agency licensing or franchise rights due to a breach of contractual agreement – or the insolvency of the group – may result in severe negative impacts on APAC Realty’s financials and reputation.

Vijay Natarajan RHB Invest | http://www.rhbinvest.com.sg/ 2017-11-30

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